Tax policy and space commercialization

“True believers” in the commercial potential for space like Richard Branson don’t need government incentives to invest in space companies, but can tax credits attract the interest of more conventional investors?

by A.J. Mackenzie

Last week in this publication (The Space Review) James Muncy skillfully described the major legislative victories won for space development last year. (See “A tale of two victories”, The Space Review, January 3, 2005.) Getting the Vision for Space Exploration funded and clearing any uncertainty about how new commercial suborbital vehicles will be regulated are big steps forward for anyone interested expanding humanity’s presence in space. Looking at the past is fine, but now’s the time to look ahead and ask this: how do you follow up those successes?

One thing, of course, is to keep NASA fully funded so it can continue to work on the Vision. That may be easier said than done, given the budgetary pressures facing Congress; the fact that NASA was one of the few agencies to get an increase last year may make it an even more tempting target. My interest, though, is on how Congress can further encourage private space development. I have a suspicion what they might try, and I’m afraid it might not work.

Over the last several years a few members of Congress have been pushing bills that would provide tax credits or other relief to promote investment in space companies. Rep. Dana Rohrabacher (R-CA), who until this year had been chairman of the space subcommittee of the House Science Committee, has been promoting his “Zero Gravity, Zero Tax” bill (HR 914 in the previous Congress) that would exclude from taxation income derived from products or services produced in space. It would also provide credits for those investing in “qualified” space companies. At the same time, Ken Calvert (R-CA), Rohrabacher’s likely successor as chair of the space subcommittee, promoted his own legislation (HR 2358 in the last Congress) that would provide similar credits for investing specifically in space transportation companies.
The idea behind tax credit proposals is to encourage private funding of space startups by giving investors an immediate reward for putting up their money, regardless if the startup eventually succeeds or fails.

Despite the efforts of the so-called “alt.space” community, both bills were referred to the Ways and Means committee, where they died. However, it’s quite possible that either or both will be reintroduced in some form this year. Calvert in particular will now have a pulpit from which to promote his proposal, although Rohrabacher showed that this is not necessarily effective.

The idea behind both proposals, of course, is to encourage private funding of space startups by giving investors an immediate reward for putting up their money, regardless if the startup eventually succeeds or fails. This reward, then, would convince otherwise recalcitrant investors to pony up, know that even if they lose their money, they still got a tax credit out of it. I’ve even seen some commentators take tax policy and space to extremes: on the Space Politics weblog last week one person claimed that the proposals by liberals to roll back President Bush’s tax cuts for the wealthy, including those like Paul Allen who have already invested in space ventures, meant that the “far left is not only against public space travel, but the private kind as well.”

Extreme claims like that, as you might imagine, can be easily dismissed. If we go back to the late 1990s, before the Bush tax cuts and when (horrors!) a Democrat was in the White House, there was still money flowing into private space ventures. Indeed, the mid to late 90s was the peak of a space boom, as wealthy people like Walt Anderson, Andrew Beal, Bill Gates, and Craig McCaw invested tens, even hundreds, of millions of dollars in companies like Beal Aerospace, Rotary Rocket, and Teledesic. These ventures all failed. One can make the case that even if tax reform magically allowed these people to double or triple their investment, these companies would have still failed because of changes in the market (notably, the telecom bust) or other fundamental flaws in their business plans.

But what about more targeted tax incentives, like Calvert’s and Rohrabacher’s proposals? Well, even without those tax credits, there still has been considerable investment in space startups. Allen reportedly put up about $25 million to develop SpaceShipOne, and now Richard Branson plans to spend up to $100 million to develop a commercial successor. Jeff Bezos has put some fraction of his Amazon.com billions into his secretive space startup, Blue Origin, while Elon Musk has reportedly invested tens of millions of his own money into SpaceX. John Carmack has spent a lesser, but still significant, sum on Armadillo Aerospace.

That’s great, but proponents of tax credits will argue that these incentives will encourage more people to invest in space companies. There are certainly other worthy companies out there to invest in, but are there really people sitting on the sidelines waiting for tax credits to take the plunge? My gut feeling is that such credits won’t help much.

Why am I so negative? I believe that, credits or not, space transportation and related companies just aren’t that attractive from the standpoint of typical investors, particularly large institutional investors. Such investors are looking for companies that quickly—on the order of just a few years—grow and thrive, or at least do well enough to provide investors with an exit strategy in the form of an acquisition or IPO. Major investors know that most of the companies they invest in may fail, but they hope to have one or two “home runs” that will more than make up for their failures (in much the same way Boston Red Sox fans remember infielder Mark Bellhorn for his game-winning home run in Game 1 of the 2004 World Series, not for leading the American League in strikeouts the same season.)
Credits or not, space transportation and related companies just aren’t that attractive from the standpoint of typical investors, particularly large institutional investors.

Using those criteria, space ventures don’t look that appealing. For one, they have long gestation periods. As an example, look at Virgin Galactic, Branson’s space tourism venture. Branson announced his investment in 2004, but it will be at least 2007 before the company will have a chance of recording any revenue. Worse, that’s with the vehicle technology the company needs already having been developed and tested—in the form of SpaceShipOne—over the course of several years. Those kinds of timelines would try the patience of most investors, given the plethora of other opportunities that could pay off in a much shorter time period.

Second, commercial space is still a small market. When telecommunications ventures that just happen to use satellites (like satellite TV providers) are eliminated, the space industry looks remarkably small: just $37 billion in 2002 revenues, or less than a single quarter’s revenue for GM. (See “What is the ‘space industry’?”, The Space Review, July 14, 2003) Most of that is tied up in what one might call “legacy” space applications: the manufacture and launch of big communications satellites, a field where there’s plenty of competition and little chance for a startup to have much success. Even space tourism, touted by the alt.space community as the savior for commercial space, looks tiny: the Futron study shows tourism won’t get above a billion dollars a year in revenues until the end of the next decade. That’s not a lot of money to chase after in the big picture.

Tax credits are based on the premise that the business plans for space transportation or other space startups can almost close, and the existence of the credits will be enough of an incentive for dispassionate investors to take the plunge. But, as shown above, space doesn’t look that enticing: the potential payoffs are small and will take years to develop. There are also all the risks associated with any high-tech startup, from technologies to markets, that a venture has to overcome to make its investors any money. Given those obstacles, it’s tough to see tax credits as enough of a carrot to get investors off the sidelines.

So what about those people who have put money into space ventures? Are they throwing their money away? Maybe. However, current investors are, by and large, “true believers”. They believe that space development is an essential part of our future, and are willing to spend money they made in other fields to try and make their dreams a reality. They’re willing to accept the risks, and willing to wait the years it takes for their ventures to blossom. These people don’t need tax credits to be convinced to part with their money.
It will take a lot of careful thought to develop incentives that can stimulate markets and be within the reach of commercial developers—a lot more work for the government than just setting up and paying out tax credits.

If tax credits won’t work, is there anything else the federal government can do to promote the development of commercial space ventures? Well, instead of creating investors and hope markets will follow, how about helping create markets and seeing if investors will follow? A classic role for government has been to stimulate markets by creating demand for private companies to service. There have been a variety of proposals along these lines in the recent past, from “pay-on-delivery” commercial ISS supply arrangements to data purchase contracts to prizes. Properly used, these can provide startups with a revenue flow and an opening to more commercial markets. These companies then start to look a little more attractive to some conventional investors. (Even better, these incentives cost the government virtually nothing until and unless the commercial sector actually delivers, which make them enticing to fiscal conservatives… if there are any left in Washington.)

Of course, it will take a lot of careful thought to develop incentives that can stimulate markets and be within the reach of commercial developers—a lot more work for the government than just setting up and paying out tax credits. But tax credits seem like the wrong solution: they work on the assumption that there aren’t enough investors. However, there are investors—perhaps not enough for every startup, but enough to support several—but there may not be enough markets. What these “true believer” investors need are not tax credits, but markets for their ventures to pursue. Let’s see if Congress is listening.